Information asymmetry and earnings management: Evidence from companies listed on the Tehran stock exchange

Abstract

Accounting standards allow managerial discretion in the application of accounting methods, preparation of financial reports and disclosures. Previous literature indicates that almost all companies are engaged in some type of earnings management (Healy, 1985; Perry & Williams, 1994; Defond & Jiambalvo, 1994; Jordon, Clark, & Pate, 2008). A fundamental question posed for accounting research is to identify the environmental conditions under which accounting choices are made by managers. Using empirical analysis this paper examines one of the fundamental conditions of earnings management which is information asymmetry between managers and investors. When information asymmetry is high, stakeholders do not have sufficient resources, incentives, or access to relevant information to monitor managers’ actions, which gives rise to earnings management. Empirical results show that the level of information asymmetry index which is the combination of five important Tehran Stock Exchange (TSE) relevant proxies (volume of trade, stock price variation, P/E ratio, number of trading days and firm age) has a positive statistically significant effect on the extent of earnings management practiced by companies listed on the TSE.